One HUGE difference between being an employee and being self-employed is the need to pay estimated taxes throughout the year. Stay with me for the details!
The focus of my practice in Severn, MD is to help taxpayers get in compliance with their IRS and state tax filings and to represent them before the IRS and the states with their tax collection issues. A recurring theme that I see with my self-employed clients who have IRS collection problems is that they failed to pay estimated taxes, so I just wanted to go over the basics of employment and withholding taxes.
Paying income and employment taxes when you’re an employee is easy since it’s your employer’s responsibility to withhold those from your paycheck. One of the first things that you’ll do when you begin a new job is to fill out a Form W-4 “Employee’s Withholding Allowance Certificate”. The information that you provide on this form will allow your employer to calculate the amount of Federal income taxes to withhold from your paychecks (as well as the state income taxes unless you live in one of the 7 states that have no personal income tax).
While the amount of income taxes withheld from your paychecks is based on your W-4, the FICA tax is a set percentage. FICA stands for Federal Insurance Contributions Act and is made up of a Social Security portion (for retirement) and a Medicare portion (for hospital insurance). These are also referred to as “employment taxes” and are used by the Federal government to pay benefits for older Americans who’ve already paid into the system. Approximately 7.5% of gross income is withheld from an employee’s paycheck for employment taxes, and the employer pays another 7.5% for the employee. Keep in mind, though, that you’re only paying Social Security on the first $128,400 of your wages in 2018.
So, as a self-employed person, what taxes do you need to be paying quarterly? That’s a good question, and I’m glad you asked. The taxes that you need to pay quarterly are called “Estimated Taxes” because that’s exactly what you’re doing—estimating the amount of taxes that you’re going to owe when your return is filed, and then sending those amounts in to the IRS and to the state. The taxes you’ll need to pay quarterly when self-employed are the same income and employment taxes as an employee pays but with a few differences:
- There’s no W-4 form and no employer to calculate your income taxes withheld, so you’ll need to determine what your effective tax rate on your previous year’s tax returns were for both Federal and state.
- You’ll need to pay the full 15% of your employment taxes. (While having an employer to cover half of your employment taxes is certainly a perk of being an employee, I think that the benefits of being self-employed are still greater!)
- The amount of taxes you pay for both income and employment are calculated based on your net income after expenses are subtracted and NOT on your gross income collected. (An employee pay only 7.5% in employment taxes but it’s based on their gross pay.)
The dates that your quarterly estimated income tax payments were (and are) due for your 2018 tax return are 4/15/18, 6/15/18, 9/15/18 and 1/15/19. While they’re called “quarterly” payments, you can see that they’re not exactly divided up evenly. If your income is uneven, with some quarters having much higher income than others, you’ll want to make your estimated tax payment calculations using that quarter’s net income. If your income is earned evenly over the year, however, it would be safe to pay an equal amount each quarter.
If you want to avoid all chances of having an underpayment penalty caused by not paying enough in quarterly estimated tax payments, there are some “Safe Harbor” options that will help:
- If you owe less than $1,000 on your Federal income tax return when it’s filed.
- If you’ve paid at least 90% of the total tax liability shown on your current year return (the return you’re filing now).
- If you just proactively paid 100% of the total tax liability that was due on your prior year return.
Keep in mind that you may still owe INTEREST on your underpayment, but you can generally avoid having to pay an underpayment penalty if you fall into one of the three situations above.
My goal is to help taxpayers meet their tax filing obligations, to pay the least amount of tax legally possible, and to represent them when they have an IRS or state collection issue. I have clients not only in Severn, MD and Anne Arundel County, MD but all over the world since technology has made our world much smaller and our ability to work remotely much easier. Come see me or just give me a call if you’re a candidate for an IRS streamlined installment agreement or if you need help in getting compliant with your IRS and state tax filings. You can reach me at:
Lisa D Church, CPA, EA, NTPI Fellow, MBA
7865 Clark Station Rd
Severn, MD 21144